Economics Lec 1 (Ch 19) Overview of Macroeconomics PDF

ECONOMICS LEC.1 (CH.19) Reliance on well-regulated private markets for most economic activity, Overview of Macroeconomics stable policy, high saving...

ECONOMICS LEC.1 (CH.19) Reliance on well-regulated private markets for most economic activity, Overview of Macroeconomics stable policy, high savings and MACROECONOMICS is the study of the investments, openness to int’l trade, behavior of the economy as a whole. and accountable and non corrupt governing institutions. It examines the forces that affect firms, consumers, and workers, in the OBJECTIVES: aggregate (a whole formed by High levels and rapid growth of output several disparate elements). High level of employment with low involuntary unemployment. 2 CENTRAL THEMES Stable prices 1. Short-term fluctuations in output, employment, financial conditions, and INSTRUMENTS: prices, called business cycles. Monetary policy - buying and selling 2. Long term trends in output and living bonds, regulating financial institutions standards, known as economic Fiscal policy - Gov’t expenditures, growth. taxation 3 CENTRAL QUESTIONS: 1) Why do output and employment MEASURING ECONOMIC SUCCESS sometimes fall; how can unemployment The goals of macroeconomic policy: be reduced? 1. High & growing level of nat’l output. The lives and fortunes of millions of 2. High employment, low unemployment. people depend upon whether 3. Stable or gently rising price level. economists find correct diagnoses for OUTPUT major macroeconomic ailments—and Gross Domestic Product (GDP) upon whether governments apply the ➔ The measure of the market value of all right medicine at the right time. final goods and services produced. 2) What are the sources of price inflation and how can it be kept under control? Nominal GDP To define, inflation is a sustained Measured in actual market prices. increase in the general price level in Current year quantity output an economy, i.e. the increase in cost multiplied by the current market of living. (%) price (simple TR = PQ). Hyperinflation - extreme rising Real GDP Galloping inflation - rise in the rate of Calculated in constant or invariant 50, 100, or 200% prices, e.g. amount of rice x price of Moderate inflation - rise in price rice in a given year. doesn’t distort relative prices Growth rate of Real GDP (%): 3) How can a nation increase its rate of 𝐺𝐷𝑃 𝑜𝑓 [𝑦𝑒𝑎𝑟] − 𝐺𝐷𝑃 𝑜𝑓 [𝑦𝑒𝑎𝑟−1] × 100 economic growth? 𝐺𝐷𝑃 𝑜𝑓 [𝑦𝑒𝑎𝑟−1]  Potential GDP 𝑃 𝑜𝑓 [𝑦𝑒𝑎𝑟] − 𝑃 𝑜𝑓 [𝑦𝑒𝑎𝑟−1] × 100 𝑃 𝑜𝑓 [𝑦𝑒𝑎𝑟−1] Represents the max. sustainable level of output that the economy Deflation can produce. ○ Occurs when the rate of inflation is negative, i.e. when prices decline. EMPLOYMENT Defining Related Terms HEADLINE INDICATORS WAP (Working Age Population) (WAP) These are the indicators of economic ○ In the Philippines, everyone who is development, i.e. the targets which we must 15 y/o and over is part of WAP. achieve in order to economically develop.. Labor Force GDP increased growth rate ○ % of WAP who are either employed or unemployed and looking for work. Global Innovation Index improved rank ○ Those unemployed that are not ○ Measures the country’s technological looking for work are excluded. improvements Employment Rate Global Competitiveness Index rank and ○ % of the Labor force that is working. score improved ○ To be competitive we must have Unemployment Rate productivity?, lower costs, etc. ○ % of the Labor force that is not working but is looking for work. Unemployment rate decreased Underemployment Rate Percentage of wage and salary workers ○ % of the Employed who are looking in private establishments to total for more work. employed increased. ○ Measures quality of employment PRICE STABILITY (high quality = high income) Price stability is defined as a low and stable Gross National Income per capita inflation rate. To track prices, increased government statisticians (PSA) construct ○ Factor Incomes price indexes. Poverty Incidence reduced Consumer Price Index (CPI) (“P”) ○ Measures the trend in the average Food Inflation rate kept stable price of goods and services bought Headline Inflation rate kept stable by consumers. National Government deficit to GDP ratio ○ We will generally denote the overall declined. price level by the letter P. ○ Fiscal policy of Government Rate of Inflation ○ At this point, the Consumer Price Outstanding National Gov’t debt stock to Index is denoted as P. GDP ratio reduced ○ Rate of Infl. for a particular year (%): TOOLS OF MACROECONOMIC POLICY More in-depth examples from ChatGPT: POLICY INSTRUMENT - an econ. variable Changing Interest Rates that can affect one or more of the By raising or lowering interest rates, BSP affects how expensive it is to borrow money. macroeconomic goals. Two of which are: This influences spending by businesses and FISCAL POLICY consumers. Denotes government expenditures and use Open Market Operations of taxes. Buying or selling government securities (like bonds) to add or remove money from the Government Expenditures economy. When the BSP buys securities, it Spending on goods and services - puts more money into the economy, and when construction of roads, purchases of it sells, it takes money out. tanks, salaries for teachers, etc. Reserve Requirements Transfer payments - a way to Requiring banks to keep a certain amount of money in reserve. If it lowers the reserve redistribute wealth; increases the requirement, banks can lend more money, income of the elderly or unemployed. increasing the money supply. Raising the Taxation requirement means banks lend less, reducing Taxes affect people's disposable the money supply. income which therefore affect the INTERNATIONAL LINKAGES amount people spend and save. As economies become more closely linked Taxes affect the prices of goods and (globalization) through trade and factors of production and thereby finance, policy becomes more affect incentives and behavior. important, particularly in small, open MONETARY POLICY economies like the PH. Done through managing the nation’s Trade Policies money, credit, and banking system Export > Import → Surplus! which is achieved through the Bangko Import > Export → Deficit… Sentral ng Pilipinas. How? Consists of tariffs, quotas, and other By setting short-run interest-rate regulations that restrict or encourage targets and through buying and selling imports and exports. government securities to attain those targets. International Financial Management Through its operations, the BSP Foreign exchange systems are an influences many financial and integral part of monetary policy. economic variables, such as interest A country’s int’l trade is influenced rates, stock prices, housing prices, and by its foreign exchange rate, which foreign exchange rates. is the price of its own currency in These in turn affect spending on terms of other currencies. investment, particularly in housing, In small open economies, managing business investment, consumer exchange rate is the most important durables, and exports and imports. macroeconomic policy. ECONOMICS LEC.2 (CH.19) HOMEWORK Overview of Macroeconomics 1) What was the GDP of the Philippines in 2023? In the first 2 quarters of 2024? Aggregate Supply describes how much output businesses would willingly → 2023 : 437.15 Billion USD produce and sell given prices, costs, → 2024 Q1 : +5.7% = 462 Billion USD → 2024 Q2 : +6.3% = 464.69 Billion USD and market conditions. Price Level and Costs 2) By how much did the purchasing power Potential Output of the peso decline from the year you were born to 2023? Capital, Labor, Technology “The purchasing power of a consumer’s Aggregate Demand consists of the peso measures the change in the value to total spending in an economy by the consumer of goods and services that a peso will buy at different dates.” households, businesses, government, 𝐶𝑃𝐼 𝑏𝑎𝑠𝑒 𝑑𝑎𝑡𝑒 (𝑃𝑃 = × 100) and foreigners. It represents the 𝐶𝑃𝐼 𝑡𝑎𝑟𝑔𝑒𝑡 𝑑𝑎𝑡𝑒 total output that would be willingly → 2005 CPI (2000=100) = 133.7 → 2024 CPI (2018=100) = 125.78 bought at each price level, given the 125.78 monetary and fiscal policies and 𝑃𝑃 = 133.7 × 100 other factors affecting demand. 𝑃𝑃 = 0. 94 × 100 Monetary policy 𝑃𝑃 = 94% ?? Fiscal policy Other forces Equilibrium where AS meets AD denotes the overall macroeconomic equilibrium which determines both the aggregate price level and output Nota Bene: In macroeconomics, the equilibrium does not represent the best conditions, at times an economy can do more (potential). Interaction between AS and AD: Output (Real GDP) Employment and Unemployment Prices and Inflation Foreign trade, etc. ECONOMICS LEC.2 (CH.20) yeast that went into the bread or the chips and plastic that went into the Measuring Economic Activity computers (Intermediate Products). Gross Domestic Product ★ This is the most comprehensive measure of a nation’s total output of goods and services. It is the sum of the dollar values of consumption (C), gross investment (I), government expenditures (G), and net exports (X) produced within a nation during a given year. ★ It is simply: GDP = C + I + G + X Details of National Accounts TWO APPROACHES ★ When using these two approaches, Real GDP vs. Nominal GDP the sums must be equal. 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 𝑃𝑄 ★ 𝑄 = 𝑅𝑒𝑎𝑙 = 𝐺𝐷𝑃 𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 𝑜𝑟 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = 𝑃 Flow-of-Product Approach (Upper Loop) ★ If there is 1% change in price from ★ Measures the GDP by adding base year (GDP Price Index) and together the consumption purchases. Nominal GDP of $1,000,000.00, then: Final goods and services (bread, $1,000,000 $1,000,000 = = $990, 099. 01 computers, haircuts, etc.) 1 + 0.01 1.01 ★ GDP = (price of blue jeans number Consumption (C) of blue jeans) plus (price of apples ★ Consists of durable and nondurable number of apples) and so forth for goods, and services all other final goods. ★ This is what’s most used. Investment (I) ★ Change in Capital; Capital Formation Earnings/Income Approach (Lower Loop) ★ Additions (marginal) to the nation’s ★ Measures the GDP by adding the capital stock (such as buildings, earnings of the households, what equipment, etc.) for the year. they used for consumption, which are also business costs. Real vs Financial Investments ★ Productive services (wages, rents, Real Investment profits, etc.) ○ Included in GDP ○ Production of durable capital “Value-Added” Approach Financial Investment ○ To avoid “double-counting”, we ○ Not included in GDP simply include the bread and home ○ Buying stocks, bonds, etc. computers (Final Products) in GDP but avoid including the flour and  Gross vs Net Investment Gross Investment ○ Overall total investments Deficiencies of GDP Net Investment There are important outputs, also ○ Net = Gross - depreciation considered as economic activity, but are not included in the GDP. Government Expenditures (G) ★ What the gov’t spends (gov’t worker Omitted Non-market Activities salaries, tanks, books, etc.), but not ★ Human capital → College students all are part of GDP. ○ Tuition is included, but not the ★ Transfers, payments that are not in Opportunity Cost of earnings exchange for any output (pension, foregone (choice: study > work) financial assistance, etc.), are not ★ Household Activities → unpaid work part of GDP since GDP only ○ Efforts on meal preparation, measures output. laundering, child & elderly care, … ★ Value of leisure time ★ Illegal Activities - some countries GDP to Disposable Income include estimates coz NI is very low ★ GDP = C + I + G + X ★ Informal Economy - included in our ★ Net Domestic Product = GDP - Dep’n GDP but only by estimate ★ Nat’l Income = NDP - indirect Taxes Omitted Environmental Damage ★ Personal Income = NI - corp. Taxes - Omits the side effects of economic activities corp. Savings + Transfer payments [a.k.a. Externalities] : ★ Disposable Income = PI - personal ★ Pollution - air, water, health damage Taxes = Consumption + private ★ Destruction of Forests Savings Augmented National Accounts Savings - Investment Identity ★ Tries to include as much economic GDP to DI Reversed: activity as is feasible, whether or not ★ DI + Tp = PI it takes place within the market. ★ PI - Tr + Sc + Tc = NI ★ NI + Ti = NDP ★ NDP + Dep’n = GDP = C + I + G + X Getting “S = I” Identity (combine ↑): C + Sp | + Tp | - Tr + Sc + Tc | + Ti | + Dep’n = C + I + G + X C + Sp | + Tp | - Tr + Sc + Tc | + Ti | + Dep’n = C + I + G + X REGROUP (put G left): Sp | + Tp | - Tr + Sc + Tc | + Ti | + Dep’n = I + G + X Sp + Sc + Dep’n + {[(Tp + Tc + Ti) - G] - Tr} = I + X Sp + Sc + Dep’n + (Sg) = I + X STOTAL = I + X a.k.a. Foreign Investments Or Simply: S = I ECONOMICS LEC.3 (CH.21) increase in consumption as disposable income increases. Consumption and Investment ○ As “what’s not consumed is saved”, CONSUMPTION the marginal propensity to save is simply MPS = 1 - MPC. Consumption Function “C is the function of disposable income” Remember: Macroeconomic Equilibrium! “C = f (Yd)” Denotes the relationship between level Where the D and S curve intersect; it’s not always the optimal point. of consumption expenditures and level Conditions of equivalence: AS = AD ; of disposable income. S=1;Y=C+I+G+X What’s not consumed is saved therefore SAVINGS = Yd - C The 45° line and the Break-even point Other Determinants: Permanent Income → income after removing temporary influences due to windfall gains or losses Life Cycle → assumption that people save in order to smooth their consumption over time. Wealth “C is also function of other determinants” “C = f (Yd, Yp, LC, W)” Linear Assumption From linear function: y = mx + c The 45° line is equidistant to both axes y → C (consumption) therefore denoting WHERE C = Yd x → Yd (disposable income) ○ Above → consumption > income m → b (marginal propensity to consume)* ○ Below → income > consumption c → a (autonomous consumption)* ○ The gap between 45° line and consumption function denotes the Therefore: savings, may it be (+), (-), or zero: C = b | Yd | + a or [C = a + bYd] The Break-even point where the 45° line intersects the consumption function denotes WHEN C = Yd ADDT’L DEFINITIONS: Autonomous Consumption (a) → Savings Function vertical intercept: level of consumption Since “what is not consumed is saved”, even when disposable income is zero. to get the savings function graphically: Marginal Propensity to Consume (b) → ○ Extend the vertical axis downward slope of the consumption function: the [Yd = 0, therefore S = (–)]  ○ Plot first point from 0 down to Important Identities negative (consumption value): If (for this chapter) consumption function starts at +10, savings function starts at -10. C = a + bYd S = -a + (1-b)Yd intercept → (+a) intercept → (-a) ○ Plot the second point by drawing a slope → (b) slope → (1-b) vertical straight line from the break-even point (where savings is MPC = ∆𝐶 =b MPS = 1-MPC = 1-b ∆𝑌𝑑 zero) to the x-axis. ○ Connect and extend the two points. Multiplier Model (YE1) = a[1/(1-b)] Numerically, personal Savings is simply Multiplier Model (YE2) = YE1 + I0[1/(1-b)] Sp = Yd - C. To get the savings function, keeping in mind the linear assumption of the consumption function, C = a + bYd: INVESTMENT SUBSTITUTE: Sp = Yd - C Two Roles in Macroeconomics: Yd - (a + bYd) A large component of spending; often Yd - a - bYd leads to changes in AD and affects the REGROUP: business cycle. Sp = -a + Yd - bYd Since investment = addition to capital, -a + (Yd - bYd) it leads to capital accumulation; FACTOR OUT: increases country’s potential output [Sp = -a + (1 - b)Yd] and growth (can move PPF outward). Multiplier Model 1 → Consumption *Note: Real investment only occurs when For this first model, I G and X = 0 real capital is produced (buildings, land, YEXAMPLE 1 = C + I + G + X machines, etc.) YE1 = C YE1 = a + bYd REGROUP: Determinants of Investment YE1 - bYd = a Total Social Investment is comprised of: FACTOR: Foreign Investment YE1(1 - b) = a Government Investment - healthcare, ISOLATE YE1: 𝑌𝐸1(1−𝑏) 𝑎 roads, gov’t workers’ salaries, etc. = (1−𝑏) (1−𝑏) Intangible Investment - human capital, 1 knowledge, etc [YE1 = a ( (1−𝑏) )] Private Domestic Investment - this will only be our focus Investment decisions are based on: Level of output produced by new invs Interest rates and taxes  Business expectations about the state Getting Y = C + I + G: of the economy Applying the determined value of G with X remaining equal 0 YEXAMPLE 3 = C + I + G + X Multiplier Model 2 → C + Investment YE3 = C + I0 + GWHEN Yd IS ZERO (0) Assume that: Investment is AUTONOMOUS, YE3 = a + bYd + I0 + G0 meaning it is a fixed amount not influenced REGROUP & FACTOR: by income. (It is, however, a function of interest rate, YE3 - bYd = a + I0 + G0 which is affected by money supply. Only then will it be YE3(1 - b) = a + I0 + G0 influenced.) ISOLATE YE3: 𝑌𝐸3(1−𝑏) 𝑎 𝐼𝑜 𝐺𝑜 = + + For this second model, G and X = 0 (1−𝑏) (1−𝑏) (1−𝑏) (1−𝑏) YEXAMPLE 2 = C + I + G + X 1 1 1 𝑌𝐸3 = 𝑎( (1−𝑏) ) + 𝐼𝑜( (1−𝑏) ) + 𝐺𝑜( (1−𝑏) ) YE2 = C + IWHEN Yd IS ZERO (0) 1 YE2 = a + bYd + I0 [YE3 = YE2 + G0( (1−𝑏) )] REGROUP & FACTOR: YE2 - bYd = a + I0 YE2(1 - b) = a + I0 Taxes in the Multiplier Model ISOLATE YE2: Caters to the question: where did the gov’t 𝑌𝐸2(1−𝑏) 𝑎 𝐼𝑜 = + get what they spend? Through TAXES. (1−𝑏) (1−𝑏) (1−𝑏) 1 1 Including taxes, the consumption function 𝑌𝐸2 = 𝑎( (1−𝑏) ) + 𝐼𝑜( (1−𝑏) ) changes (lowers): (Yd IS ALSO INCOME - TAXES) [YE2 = YE1 + 1 I0( (1−𝑏) )] C = a + bYd C = a + b(Y-T) C = a + bY - bT ASSUMING IT IS HEAD TAX (EQUAL FOR ALL): Multiplier Model 3 → C + I + Gov’t [C = a - bT0 + bY] If C + I hasn’t reached Y*, the government must come in (fiscal policy) to increase AD and achieve potential. Before we determine YE3 (or C + I + G), we must get G first: Identifying the Value of G: Here’s to get how much gov’t must increase in spending or how large the gap is: 1: Get the multiplier = [1/(1-b)] 2: Use the same principle as E1 and E2 Y* = YE2 + gap(multiplier) ISOLATE “GAP”: Y* - YE2 = gap(multiplier) 𝑌*−𝑌𝐸2 (𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟) = 𝑔𝑎𝑝 or: 𝑌*−𝑌𝐸2 [gap = (𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟) ]